In my career as a financial advisor, I’ve made a few mistakes. The biggest? Not being more convincing to my clients that they should stay invested in rough markets.
I became a licensed financial advisor in early 2003. People were still really skittish over the bad market – even though it was improving. The news was still mostly bad and little provocation was needed to make people sell their investments again. It seemed to stay that way for the next few years.
Finally, around 2006 or 2007, I stopped hearing as much about the days “back in the bad market.” I suppose time began dimming some memories. And then, 2008 happened. This was an incredibly difficult year in the stock market but I did everything I could do to calm the nerves of my clients and friends. Some listened to me. Others went against my advice and sold all of their investments.
Most of these people locked in devastating losses by selling at the worst possible time. And most couldn’t afford it. If they would have just stayed invested, they would have most likely made up those losses and then some. Since then, I’ve often wondered if I could have done more to keep them invested?
Five Lessons I Learned from Market Declines
One thing’s for sure: I learned a few lessons from those down markets. In the next bear market I’ll be much more vocal in sharing the five things I learned from market declines.
1. Market declines are normal.
Don’t ever believe that it’s abnormal for the market to get really volatile on an occasional basis. If you look at the historical averages, market declines are normal. Over the last 100 years, on average, the market has experienced a 10% drop at least one time per year. Over the same period, a 20% decline occurs once every 3.5 years and a 30% decline occurs once every 10 years.
There are a lot of years when the market has a big scary decline during the year but finishes up with a positive return! Look at the chart below from JP Morgan. The dark bars show the total return for the year, and the red numbers show the drop that occurred at some point during the year.
Here’s a great example from this chart. In early 2003 the recovering market dropped 14%. This was in the early days of my career as a financial advisor and I can tell you that almost no one believed that 2003 would be a positive year for the markets. Most were sitting in cash waiting for “things to change.” Well, things did change – and fast! At the end of 2003 the market posted a total return of 26%! Who would have thought that during a 14% decline?
Obviously, market declines are nothing new. But I know they are painful when they happen. And they can seem to last forever when you’re in the midst of the turmoil! Thankfully, history offers us some reassurance that this too shall pass, and maybe even a little more quickly than we think. According to CNBC, the market fully recovers within 15 months after a bear market.
So hang on! Better days are coming. Just because the market is down now, that doesn’t mean it’ll finish the year in negative territory.
2. No one can consistently predict market movements.
I wish I could time the markets. It looks so cool. Those who do it get lots of time on the financial TV channels like CNBC and Fox Business. They’ll often appear with charts that back up their projections and make a compelling case for their forecasts.
Here’s the problem: it doesn’t work.
Why? You not only have to know when to get out, but when to get back in. To be successful, you have to be right over and over. I love what Rick Ferri said in his Forbes article: “Guessing right once is a 50/50 proposition. Guessing right twice drops the odds to only 25 percent. One wrong guess and you shoot yourself in one foot; two wrong guesses and you shoot yourself in both feet. This is what makes market timing so difficult.”
So what’s the record of these experts we see on CNBC and the other channels? From 2005 through 2012, CXO Advisory collected 6,582 forecasts for the U.S. stock market offered publicly by 68 experts. The intent was to see if some individuals can actually provide reliable stock market timing guidance.
The result from the experts? They were right 47% of the time. That doesn’t cut it.
Have you heard the saying, “Even a stopped clock is right twice per day?”
3. The best days hang out with the bad days.
What happens if you overreact when you see the markets “plunging” (an overused term by the financial media) and sell?
Based on history, the markets will often rebound in the days shortly after a big sell-off. Consider the days listed in the chart below. The losses (in the blue columns) were some of the biggest single day declines in the last 20 years. The orange column was the big bounce that occurred within a day or two of the decline.
It would have been fairly easy in any of those negative days to get out of the market. But if you would have, you would have missed the bounce back in the following days. Because so much of the market’s return is concentrated in a few days, it’s not likely you would ever get that return back. Effectively, you would have turned temporary misery into permanent misery.
So what happens if we look at the concentration of those days over a longer time period?
Over the past 20 years the market has averaged 9.85% in average annual returns. If you missed just 10 of the best days your return would slip to 6.11%. If you were out of the market for 40 of the best days, your return would have been negative!
It’s pretty apparent that successful investors can’t afford to miss many of the big return days.
There are those who disagree with charts such as these when they are used to support the buy-and-hold argument. I’ll listen to what they have to say, but until those who disagree with me can show me a better way, I’ll stay invested.
4. This time is not different.
The quote by Sir John Templeton is often repeated and for good reason: “The four most expensive words in the English language are ‘this time it’s different.'”
Take a look at all of these world events that had an effect on the markets:
- 1960s: Cuban Missile Crisis, Vietnam War escalation, American spy plane shot down over Soviet Union
- 1970s: Arab oil embargo, stagflation, Watergate
- 1980s: Savings and loan crisis, Latin American debt crisis, failed military attempt to end the Iranian Hostage Crisis
- 1990s: Asian financial crisis, Persian Gulf War
- 2000s: September 11 attacks, subprime lending/housing meltdown, Great Recession
- 2010s: Nuclear threats from North Korea, Greek bailout and eurozone crisis, mortgage delinquencies peak above 14 percent
Now, tell me, is the situation you’re worried about unlike these? While it might be in the details of the situation, as far as the overall effect on the markets, it most likely looks like history that is simply repeating itself.
5. The greatest threat to your portfolio return is not the market.
From the end of 1985 to the end of 2015 the S&P 500 Index averaged 9.85% per year, according to Dalbar. That’s a pretty good return! The average equity fund investor earned a market return of only 5.19%.
Do you know why most investors have very mediocre investment returns? Emotions. The greatest danger you face in your portfolio return is not China, rising interest rates, or any of the other numerous threats constantly discussed in the financial media. Your greatest adversary is yourself. Specifically, it’s how you process the emotions of fear and panic.
The urge to “do something before it’s too late” can set in like a small hot fire. The financial news acts as fuel and quickly escalates this small fire into an uncontrollable blaze. Watch enough of that garbage, and you’re doomed. You’ll sell at the worst possible time.
It’s not just you though, I’m a financial advisor with more than a decade of experience and I’m susceptible to those “flight-to-safety” emotions as well. This recent market decline has reminded me of the strength of those emotions.
The faster you recognize that you are your worst enemy, the better.
What to Expect from a Great Financial Advisor During Market Declines
So, what can you expect from a great financial advisor when the market goes downhill? Here are a few important things.
Should the market decline, your financial advisor should provide you with the advice you’d need to hear, not necessarily the advice you’d want to hear. While advice you need to hear sometimes aligns with advice you want to hear, that won’t always be the case, so your financial advisor should always provide you with straightforward advice.
Financial advisors shouldn’t buy and sell investments just to make it look like they’re doing something. A great financial advisor does a tremendous amount of work building their clients’ portfolios, and then they stick to a buy-and-hold strategy.
Unless something dramatically changes in their clients’ lives so that their goals change, the buy-and-hold strategy is a sound one that is, in my opinion, most likely to stand the test of time.
Great financial advisors understand that downtimes are scary. They will go the extra mile to proactively reach out to their clients in difficult seasons to provide insight and reassurance.
Many times, in the course of these conversations, great financial advisors learn more about their clients and are able to help them with other areas of their financial lives to bolster their financial standing without liquidating their funds.
Is your financial advisor providing this level of service? Are you uncertain about your financial future? Contact me today. I’d be happy to review your situation and give you the advice you need and deserve.